Forget Fee Compression, Most Advisors Add Big Value Even At 1% Of AUM

A full-service advisor boosts real returns by 3 percentage points above market neutral through tax sensitivity, rebalancing, asset allocation and financial planning. Communicate that story to your clients and let the robots race each other to the bottom. 


For years, conventional industry math has fixated on 100 basis points as the sweet spot that investors are willing to pay for an advisor’s expertise.

Charge much beyond that level, increasingly automated competitors will undercut your pricing and steal your clients, or so the story goes.

In reality, the typical advisor adds triple that amount of alpha to managed assets, which opens up a very different value conversation.

Envestnet crunched the numbers and found that advisors ultimately beat the market benchmarks by a full 3% a year. The 5-second version, of course, is that management fees at human-run firms still have plenty of space to avoid racing to the bottom.

If so, the automated advisory tools will only give the humans who use them effectively a chance to make those fees add up to bigger profits that can be reinvested into the business.

Reevaluating the “bundle”

As it turns out, the biggest benefit advisors can reliably provide is on the tax management side. While a lot of people in the industry outsource this piece of the platform, the advantages to the client definitely seem to make it worthwhile.

For one thing, taxes are a dependable and recurring drag on performance. Until Congress slides the bar on capital gains and dividend treatment, most investors will keep handing up to 20% of their annual performance to the IRS.

Every basis point of that tax liability that an advisor can defer through various optimization techniques -- loss harvesting, smarter approaches to holding periods and so on -- adds up to real cash accruing in client accounts.

Envestnet ran simulations and concluded that a basic tax-sensitive portfolio designed to track the broad market boosted real returns by a little more than 100 basis points per year from 1995 to 2014.

Most of the benefit came through the day-to-day work of identifying losses to match against gains, but a surprising amount of alpha emerged simply because passive buying and holding just doesn’t work in volatile markets.

Either way, the tax-optimized accounts justified the industry standard 100 basis points in management fees. Everything else advisors did beyond that point, as it turns out, is literally added value.

And with 100 basis points in client appreciation to work with on this side of the balance sheet, it’s clear that advisors who farm that task out to an outsourced partner or automated tool have room to share the revenue without running the service at a loss.

The math is simple: if clients get 100 basis points of value for the tax-enhanced service, they’ll pay up to that amount without complaint. The advisor then theoretically has up to 1% of AUM to invest in making that proposition happen.

Everything left on the table can be passed on to the client or retained as profit. And remember, everything else in the standard advisory service platform is a bonus.

Beating the benchmark without breaking the budget

Envestnet noticed that simply systematically rebalancing the portfolio adds 44 basis points of value while asset allocation contributes another 28 basis points to the annual results.

Neither of these is an expensive service to offer on an automated basis, so I’d be surprised to hear about advisors who do the work by hand.

As it turns out, picking the securities that populate each asset class bucket generally added 82 to 85 basis points to the benchmark. This is pure performance, which is what many clients come to advisors seeking in the first place.

Doing stock research is of course expensive. If you’ve already invested time and resources to build up expertise in that area, I hope the effort translates into even higher client returns.

Of course, if you’re paying more per dollar of AUM on research than you’re earning for your clients, it probably makes sense to delegate that piece of the job.

Managed and model investment programs are all over the map in terms of pricing and performance. I like seeing the Envestnet number because it gives us a handy benchmark for evaluating the outsourced portfolio.

A portfolio that charges you more than 85 basis points had better give you the ability to show your clients better returns to match.

And your clients will naturally see the difference show up in their quarterly statements. If you’re getting them better performance, they’ll not only stick around but even subsidize the cost.

After all, as long as they come out ahead after fees, they have very little reason to complain.

Add in around 50 basis points of value for financial planning – another surprise, and one that I want to explore in greater depth down the road – and it looks like advisors routinely generate 3% a year extra for clients who would otherwise buy and hold an index fund.

That’s a lot of added value. Instead of feeling guilty about charging a full percentage point, a lot of advisors should be crowing about the great deal their clients are getting.

With 300 basis points to work with, an advisor can deploy a lot of robots to do the work, give clients a price break and still make a great living.

But you have to do it right.


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